Money still matters
I occasionally see people claim that open market operations no longer matter in a world with IOER, where banks have large holdings of excess reserves. This is not true.
Here’s Peter Ireland from a 2014 paper:
[I]n the long run, the additional degree of freedom provided by the ability to pay interest on reserves is best described as one that gives the Federal Reserve the ability to target the real quantity of reserves separately from the federal funds rate. Even when it pays interest on reserves, the Fed must continue to use open market operations to adjust the nominal quantity of reserves proportionally, following any policy action intended to bring about a long-run change in the aggregate price level.
Even in a world with IOER, money is still neutral in the long run. The existence of IOER causes a large one-time increase in the demand for base money, say from 5% to 50% of GDP. But that’s a one-time rightward shift in the money demand curve. It’s still true that a permanent, exogenous, one-time doubling of the monetary base will cause the price level and NGDP to double in the long run.
In a 2017 paper, Ireland points out that open market operations remain effective in a world with IOER:
Thus, while the Fed’s newly-obtained ability to pay interest on reserves does allow it to tighten monetary policy by raising its federal funds rate target in the short run without any immediate open market operation, the long-run effects of this monetary policy tightening turn out to be the same with interest on reserves in figure 2 as they were in figure 1 without. From a monetarist perspective, the open market operation that leads to a contraction in the dollar volume of reserves supplied is still necessary for bringing about a permanent reduction in the price level.
Why is there so much confusion on this point? I suspect it has something to do with the various QE programs implemented during the recovery from the Great Recession. Large increases in the monetary base were accompanied by rather small increases in the price level and NGDP.
But this sort of stylized fact doesn’t mean that monetary injections are ineffective. The same people who are skeptical of the effectiveness of changing the money supply often argue that what is needed is a change in the interest rate target. However the Fed’s policy of cutting interest rates during 2007-08 was even less effective than the QE of 2009-13, indeed far less effective.
In both cases, the policy changes were not exogenous. In 2007-08, the target interest rate was reduced because the equilibrium interest rate was declining. In 2009-13, the monetary base was expanded because the demand for base money was rising. Naturally those policies looked ineffective; the policy changes were defensive, i.e., reactive.
In 2007-08, the Fed should have reduced the interest rate fast enough to raise NGDP growth expectations to 5%, and in 2009-13 they should have increased the monetary base enough to raise NGDP growth expectations to the 5% trend line from 2007.
In addition to Peter Ireland, Nick Rowe is someone who understands that the money supply remains important in a world with IOER. In a 2016 blog post, Nick considered a thought experiment involving an increase in the rate of interest paid on money (Rm), which might be viewed as the interest rate paid on bank reserves:
If the central bank announces that Rm increases by 1%, and at the same time announces that money growth increases by 1%, then we get Neo-Fisherian results. The inflation rate increase by 1%, but the opportunity cost of holding money is unchanged (the increased Rm and increased inflation cancel out), so there is no initial jump up or down in the price level.
But if the central bank announces that Rm increases by 1%, and at the same time announces that money growth will not change, then we get an initial drop in the price level, because the opportunity cost of holding money has fallen so the demand for money has increased, but there is no subsequent change in the inflation rate.
If we assumed prices are sticky rather than perfectly flexible, that initial drop in the price level would take a few years of deflation to work itself out.
It’s not enough to ask what happens if the central bank changes the deposit rate of interest. We must also ask what the central bank does with the money supply. And the New Keynesians (Neo-Wicksellians) are to blame by deleting that second question, by deleting money from their model.
And by the way, my model is bog-standard ISLM, except that the central bank pays interest on money, and you can make the IS curve New Keynesian if you like, and add flexible prices or an expectations-augmented Phillips Curve.
Money still matters.
Tags:
5. October 2020 at 10:18
From your blog post today… “a permanent, exogenous, one-time doubling of the monetary base will cause the price level and NGDP to double in the long run”
Friedman quote… “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output”.
The second quote saying inflation “can be produced” does not mean that inflation will be produced. I would say the monetary base does not map linear proportionately to a price level. Of course purchases and output determine the price level in the near future. In the distant future purchases and output also determine the price level and purchases are path dependent and output is path dependent and the price level is indeterminate. The indeterminacy of the price level is logically consistent with it being disconnected from the monetary base. I made these claims not because they are true but because by making them you might feel inclined to tell me why they are wrong.
5. October 2020 at 10:59
Brian, I meant that the price level would be twice as high as otherwise. I certainly do not believe that the price level and the monetary base are perfectly correlated, that would be crazy. Money demand can shift by large amounts, especially at near zero rates.
5. October 2020 at 11:04
The pandemic has resulted in a significant increase in cash in circulation. There was an initial surge back in March but it has continued rising (although at a slower rate). I have rarely used cash during the pandemic. Before, I paid personal expenses (such as meals at restaurants) mostly in cash. Since I don’t go to those places, I don’t use cash. One explanation for the increase in cash is that people are actually hoarding it (under the pillow?).
5. October 2020 at 11:23
I’m probably thinking about this the wrong way but I’m not quite getting it.
If the fed wants to keep interest rates at their natural level and uses something like NGDP or the price level as their guide then its not clear to me why OMO and IOER are not substitute policies.
In the case of OMO they vary the ratio between bonds and money held by the public to adjust interest rates, while in the case of IOER they just set the IOER-rate as appropriate and people will hold more interest-bearing money rather than buying bonds.
I see no reason why either of these policies could not (in theory) successfully maintain the natural rate of interest with no differing long term effects.
If for some reason either policy was used to attempt to maintain rates at other than their natural level then I can see that “long term money neutrality” will cause both policies to become derailed.
5. October 2020 at 11:32
A price level twice as high as otherwise probably would not happen (I think prices are indeterminate) because actual spending power money is recycled whether 0.5 times per year or 5.0 times per year. If actual spending power money is disconnected from prices then the monetary base is even more disconnected.
5. October 2020 at 14:13
Rayward, Yes, the cash is clearly being hoarded. Zero nominal interest rates is one factor.
Market, I agree that IOER can be used, but the Fed is reluctant to push it below zero. No zero bound problem for OMOs.
Brian, Whether prices are indeterminate depends on the monetary policy regime.
5. October 2020 at 16:22
With IOER currently at 10 bp and 90-day USTs at 8 bp, there is no “money multiplier” effect, so the impact of increasing M0 depends upon what the Fed buys to accomplish it.
The financial system considers USTs to be equivalent to cash, and may even be able to squeeze more total USD liquidity out of USTs than the same dollar amount of bank reserves. Accordingly, OMOs for USTs or other highly liquid, risk-free assets do nothing to increase total world USD liquidity–and may even be contractionary.
Unfortunately, the Fed has allowed itself to get so far “behind the curve” that if it wants to stop the monetary deflation that it has caused/permitted, it has to assume risk. The Fed has to trade bank reserves for illiquid assets, because the banks, which used to perform this vital function, are not willing to do enough of it under current conditions.
The creation of net USD liquidity inherently requires that some entity take the risk of trading liquid USD liabilities for illiquid assets. The Fed has backed itself into a corner where it will have to do this itself (and be criticized for “bailouts”).
Jeff Snider has written extensively about the futility of the Fed’s belief that more bank reserves cures all ills.
5. October 2020 at 16:57
Even so, what is the true purpose of interest on excess reserves?
We live in an interesting time, wherein if Scott Sumner is correct in his observations, nearly the entire community of global central bankers are wrong in their prescriptions, in that they are all calling for more fiscal stimulus.
In addition, David Beckworth is calling for a quantitative easing, but not for Wall Street, but rather to Main Street.
There is the additional muddying factor in that we live in a world of fungible money, and globalized capital markets and economies, yet the Federal Reserve is just one of several major central banks.
I don’t know which totem to genuflect to.
5. October 2020 at 20:36
Louis, We both agree that IOER was a bad idea, but money is neutral in the long run regardless of whether the Fed pays IOER or not.
The real issue is the monetary regime—we need a level targeting regime.
6. October 2020 at 02:02
“Rapid Money Supply Growth Does Not Cause Inflation
By Richard Vague
DEC 2, 2016 | FINANCE | MACROECONOMICS
Neither do rapid growth in government debt, declining interest rates, or rapid increases in a central bank’s balance sheet”
https://www.ineteconomics.org/perspectives/blog/rapid-money-supply-growth-does-not-cause-inflation
6. October 2020 at 05:16
re: “they should have increased the monetary base enough to raise NGDP growth expectations to the 5% trend line from 2007”
Economists don’t understand what the monetary base even is. And I have already repeatedly proved it.
We knew the precise “Minskey Moment” of the GFC:
POSTED: Dec 13 2007 06:55 PM |
The Commerce Department said retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006.
10/1/2007,,,,,,,-0.47 * temporary bottom
11/1/2007,,,,,,, 0.14
12/1/2007,,,,,,, 0.44
01/1/2008,,,,,,, 0.59
02/1/2008,,,,,,, 0.45
03/1/2008,,,,,,, 0.06
04/1/2008,,,,,,, 0.04
05/1/2008,,,,,,, 0.09
06/1/2008,,,,,,, 0.20
07/1/2008,,,,,,, 0.32
08/1/2008,,,,,,, 0.15
09/1/2008,,,,,,, 0.00
10/1/2008,,,,,, -0.20 * possible recession
11/1/2008,,,,,, -0.10 * possible recession
12/1/2008,,,,,,, 0.10 * possible recession
RoC trajectory as predicted.
The monetary base was equal to required reserves. The money multiplier was equal to required reserves divided by commercial bank credit.
See: “Quantitative Easing and Money Growth: Potential for Higher Inflation?
http://bit.ly/yUdRIZ
“the close relationship between the growth rates of required reserves and total checkable deposits reflects the fact that reserves requirements apply only to checkable deposits”
Read: Dr. Daniel L. Thornton, former Vice President and Economic Adviser: Research Division, Federal Reserve Bank of St. Louis, Working Paper Series, “Monetary Policy: Why Money Matters and Interest Rates Don’t”
http://bit.ly/1OJ9jhU
The base isn’t equal to the volume of interbank demand deposits. And the base actually decreased, not increased, from FEB 2006 to JUL 2008, for 29 consecutive months. The fact that it caused a recession is no happenstance. 92 percent of the fictitious base was composed of currency, where an increase of which destroys bank deposits.
Economists also still don’t know a debit from a credit. Banks pay for their earning assets with new money – not existing deposits. The remuneration of IBDDs is a Romulan cloaking device which destroys money velocity.
As As Dr. Philip George succinctly puts it: “Changes in velocity have nothing to do with the speed at which money moves from hand to hand but are entirely the result of movements between demand deposits and other kinds of deposits.”
The IOR is akin to REG. Q ceiling for the commercial banks. Raise the rate vis-à-vis money market rates and velocity falls.
The September 2019 Repo Crisis is prima facie evidence (where the remuneration rate vs. SOFR rates, Secured Overnight Financing Rate – a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities was inverted). I.e., the FED’s artificial remuneration rate interest rate inversion.
See Lyn Alden Schwartzer’s graph in The Curious Case of QE” (“chronic, systemic liquidity shortfall”), the IOR vs. 3mo Treasury Constant Maturity rate
https://seekingalpha.com/article/4320078-curious-case-of-qe
Credit is the life blood of the economy. Savings flowing through the nonbanks increases the supply of loanable funds, but not the supply of money (a velocity relationship). Why do you think money velocity has disappeared since exactly 1981? $15 trillion dollars in U.S. bank-held savings are un-used and un-spent.
6. October 2020 at 05:36
re: “money is still neutral in the long run”
That’s also not true. During the U.S. Golden Era in Capitalism (not optimized), the annual compounded rate of increase in our means-of-payment money supply was about 2 percent.
The nonbanks grew much faster than the commercial banks (which made Citicorp’s Walter Wriston jealous), and thereby a higher percentage of savings was utilized (through direct and indirect investment) and was also FSLIC and NCUA insured.
Velocity, Vt, financed 2/3 of GDP and money 1/3. Today it’s reversed with money financing 3/4 of GDP and Vt 1/4.
And during this same period, 1955-1964, the rate of inflation, based on the Consumer Price Index, increased at an annual rate of 1.4 percent. Unemployment averaged 5.4 percent.
6. October 2020 at 05:56
re: “Even when it pays interest on reserves, the Fed must continue to use open market operations to adjust the nominal quantity of reserves proportionally”
Unlike Treasury issuance, because the belligerent bifurcation (the mis-aligned distribution of sales and purchases of debt by the FRB-NY’s trading desk and its customers/counter-parties is largely unpredictable, so too now is the volume and rate of expansion in the money stock.
FOMC policy has now been capriciously undermined by turning excess reserves into bank earning assets. Interbank demand deposits were non-earning assets prior to October 2008 (where the banks minimized their balances between 1942 and 2008, always less than 1b). So, the FED has emasculated its “open market power”, the power to create new money and credit.
This is in direct contrast to targeting: *RPDs* (reserves for private deposits), as its operating method, as Paul Meek’s (FRB-NY assistant V.P. of OMOs and Treasury issues), described in his 3rd edition of “Open Market Operations” published in 1974.
This adds up to an obdurate apparatus that the Fed cannot monitor, much less control, even on a month-to-month basis. What the net expansion of the money stock will be, as a consequence of any given addition or subtraction in Federal Reserve Bank credit, nobody can forecast until long after the fact.
6. October 2020 at 06:05
Contrary to Nobel Prize–winning economist Milton Friedman and Anna J. Schwartz’s “ A Monetary History of the United States, 1867–1960 “ monetary lags are not “long and variable”. The distributed lag effects for both real output and inflation have been mathematical constants for over 100 years. Thus, we can precisely calculate any “output gap”, any “sweet spot”.
This is still doable without required reserves.
“The Making of Index Numbers (1922) is to identify the characteristics of the best feasible index of prices for use in measuring changes in the purchasing power of money. This book, in which he tried to systematize and rationalize index number theory by defining a certain number of criteria, is in fact an extension of chapter 10 of his Purchasing Power of Money and of the appendix to that book. His research into the qualities of a satisfactory price index was a by-product of his general analysis of the equation of exchange.”
“Whereas Fisher’s approach in The Purchasing Power of Money was deductive, in The Making of Index Numbers it was inductive and empirical: he compared the results of using different formulas on the same historical data. He used two principal criteria of evaluation, the “time reversal test” and the “factor reversal test,” and recommended use of the “ideal” index, the geometric mean of the Paasche and Laspeyre indices.”
“There can be no doubt that Fisher’s study, which was the most extensive at that time in the field of index numbers, was a fruitful springboard for much of the progress made subsequently [See INDEX NUMBERS].”
“Distributed lags. Fisher was the first to envisage a systematic dependence of the present on the past in economics, and thus he opened up a whole new area. The existence of systematic effects explains why it has been possible successfully to analyze economic and geophysical time series using autoregressive equations which when inverted can be written formally as in which y-t is the cumulative effect of earlier actions, εt-p, weighted by coefficients a-p, which decline with distance in time.”
“The accepted English term for this formulation, “distributed lags,” was coined by Fisher. This term is intended to convey that each εt-p acts with a certain delay, so that lags of different length must be taken into account when studying the influence of the past.”
“In his study “Our Unstable Dollar and the So-called Business Cycle” (1925) Fisher proposed a formulation of the type in which the weights α(θ) are distributed lognormally, for study of the interdependence of the level of economic activity y(t) and past values p(t—0) of the general level of prices.”
“Later, in his Theory of Interest (chapter 19, sec. 6), he used weights a, which declined linearly with time, to study the relationship between the rate of interest and earlier rates of increase of the price level.”
“The line of approach initiated by Fisher was later to prove particularly fertile in econometric thought. [See DISTRIBUTED LAGS .]”
Irving Fisher: Pioneer on distributed lags – by J.N.M. Wit
“Fisher’s theory was that any cause produces a supposed effect only after some lag in time, and that this effect is not felt all at once, but is distributed over a number of points in time. He hypothesized
that the best general form for the lag distribution is presumably the lognormal distribution. In essence, this distribution satisfies his idea that the effect will quickly reach its peak after a very short period, and then slowly taper off.”
“To find this estimate, Fisher provided a heuristic approach in case one already knows the lag length that makes the correlation between the lagged xt and yt at its maximum. A good guess for the value of n* would be three to four times the numerical value of the aforementioned lag length.”
“Fisher’s ‘Note on a Short-Cut Method for Calculating Distributed Lags’ in the Bulletin de l’Institute International de Statistique. Fisher’s contribution unintentionally provided the first parsimonious device that is able to solve the multicollinearity problem.”
Econometrics Beat: Dave Giles’ Blog
Irving Fisher & Distributed Lags (1925)
“At the bottom of p. 183, he claims that “So far as I know this is the first attempt to distribute a statistical lag” and then goes on to explain his approach to the question. Among other things, I’m still struck by the fact that Fisher’s “computer” consisted of his intellect and a pencil and paper.”
“We note at once that P’ supplies an oscillating barometer without requiring any of the corrections for secular trend and seasonal variation found necessary in most “ cycle “ data including the “ T “ here used:”
davegiles.blogspot.com/…
6. October 2020 at 06:58
The worlds’ leading guru on bank reserves, Dr. Richard G. Anderson:
Remember that “excess reserves” is an accounting concept, not a physical item. The physical item (asset) is deposits at Fed Res Banks. These deposits may be used to satisfy statutory reserve requirements; any “excess” deposits are labeled as “excess reserves.” This terminology dates from the 1920s, and I find it obsolete.
6. October 2020 at 13:50
There is not the kind of fixed relationship between base money and NGDP that you suggest. The money that actually matter for NGDP is the money used by the public for transactions, that is cash and bank deposit money.
6. October 2020 at 14:45
Scott,
If the NY Fed exchanges assets (securities) for reserves with JP Morgan, this has no more effect on the economy than if the NY Fed were to do the trade with St. Louis Fed.
Unless the there is an exchange of assets for money between the banking sector (Fed + commercial banks) and the non-banking sector (firms + individuals), then OMP will have almost no effect on the economy.
If OMP simply result in an increase in reserves, then the only way it can affect the economy is a) by impacting velocity (this effect is IMHO very small given low current low interest rates and the very small changes in those rates) or through expectations (i.e. that the commercial banks will at some point use those reserves to buy assets from the non-banking sector.)
If they money stays in the banking sector, inflation will never rise.
Money entirely within the banking system (e.g. ER) does NOT matter.
7. October 2020 at 03:03
“Some economists think that the key aggregate in monetary economics is the monetary base by itself.14 This is just wrong. In the UK QE was very large relative to the level of the monetary base in early 2009. Indeed, the monetary base rose by more than five times between the start of 2009 and mid-2013. The five-fold surge in the base provided the rationale – or rather the bogus rationale – for Liam Halligan’s forecasts in The Sunday Telegraph that QE would provoke a dramatic leap in inflation and eventually culminate in a Zimbabwe-style currency debasement. Such forecasts – and the “theory” behind them – have been invalidated by events.15”
https://mv-pt.org/wp-content/uploads/2020/05/mgr.02-Chapter-2-Congdon.pdf
7. October 2020 at 06:30
@Arilando
re: “The money that actually matter for NGDP is the money used by the public for transactions, that is cash and bank deposit money.”
That’s exactly right, and the proof is in the pudding.
In fact, non-M1 components rarely turn over. The ratio of M1 to non-M1 is c. 95:1.
7. October 2020 at 06:37
To begin with, the monetary base [sic] has never been a “base” (money multiplier), for the expansion of new money and credit. Flawed as the AMBLR figure is (Adjusted Member Bank Legal Reserves), it was superior to the Domestic Adjusted Monetary Base (DAMB) figure, which is generally cited. The DAMB figure included AMBLR (interbank demand deposits held at one of the 12 District Reserve banks, owned by the member banks, as well as “applied” vault cash, traditionally ->”prudential” or a part of a bank’s liquidity reserve balances before 1959), plus the volume of currency held by the private-sector’s non-bank public (Nobel Laureate Dr. Milton Friedman’s misnomer: “high powered money”).
Any expansion or contraction of DAMB is neither proof that the Market Group’s “trading desk” intends to follow an expansive, nor a contractive monetary policy (adding or draining interbank demand deposits, IBDDs).. Furthermore, any expansion of the non-bank public’s holdings of currency, the “cash-drain” factor, merely changes the composition (but not the total volume) of the money stock. There is a shift out of demand deposits, NOW or ATS accounts, into currency. But this shifting did reduce member bank legal reserves by an equal, or approximately equal, amount.
In other words, we have a “managed” currency system, not a “fiat” one. In a fiat system the volume of currency issued is dictated by the deficit-financing requirements of the issuing government (like the Civil War Greenback). Whereas in a managed-currency system (ours), the volume of currency in circulation is impersonally determined by the public, and the amount which meets the needs of trade.
The basic process by which currency is put into and taken out of circulation is through the banking system. The volume of currency held by the public needs no formal or specific regulation since it is impossible for the public to acquire more of a given type of currency (or even less given current operating policies), without giving up other types of currency, or else bank deposits. In other words, under our managed system it is impossible for the public to add to the total money supply consequent to increasing its holdings of currency.
An expansion of the public’s holdings of currency will cause a multiple contraction of bank credit and “total checkable deposits” (relative to the increase in currency outflows from the banks) ceteris paribus. To avoid such a contraction the desk typically offsets currency withdrawals with open market operations of the buying type (e.g., purchases of government securities for the portfolios of the Reserve Banks, an increase in the Central Bank’s System Open Market Account, SOMA). The reverse is true if there is a return flow of currency to the banks. Since the trend of the non-bank public’s holdings of currency is up (ever since 1930), return flows are purely seasonal & cannot therefore provide a permanent basis for bank credit and money expansion.
And all currency gets into circulation, directly or indirectly, through the liquidation of time deposits, by the cashing of demand deposits. There is one exception in demand deposit creation; those historical instances when the U.S. Treasury borrowed from the Federal Reserve Banks (its prior, and given sequestration, too-long since abandoned “overdraft privilege”). However, it cannot be said (as of time-savings deposits), that increases in the public’s holdings of currency reflect prior commercial bank credit creation. It is more appropriate to say that expansions of currency are accompanied by concurrent expansions of Reserve Bank Credit (Manna from Heaven).
7. October 2020 at 06:41
Complicating the measurement of the monetary base is the fluctuation in the percentage of foreign currency circulation, to domestic currency circulation. The FED’s research staff estimates that foreigners hold one half to two thirds of all U.S. currency (this spread can result in a wide margin of error). Inflows and outflows of foreign-held U.S. currency (e.g., seldom are untaxed earnings ever repatriated) are attributed to political, and price, instability (as well as to seasonal flows), and all are immeasurable in the short run. I.e., the domestic monetary source base equals the monetary source base minus the estimated amount of foreign-held U.S. currency.
The “shipments proxy” estimate of foreign-held U.S. currency uses data on the receipts and shipments of currency, by denomination, at the Federal Reserve’s 37 cash offices nationwide (note: > 80 percent of foreign-held U.S. currency are $100.00 bills). Because of its influence on the DAMB, quarterly estimates of foreign-held U.S. currency are reported in the Feds “Flow of Funds Accounts of the United States” & in the BEAs estimates of the net international investment position of the United States.
The volatility of the (1) K-ratio, the public’s desired ratio of currency to transactions deposits (or currency-deposit-ratio), and the volatility in (2) the ratio of foreign-held, to domestic U.S. currency, both influence the trend rate for the cash drain factor (the movement of the domestic currency component of the DAMB). And the evidence points to sizable (& unpredictable), shifts in the money multiplier (MULT – St. Louis), for the constantly changing shifts in the composition of the “M’s”.
The Federal Reserve Bank of Chicago uses legal reserves (“t”-accounts), exclusively, to explain the creation of new money and credit in the booklet “Modern Money Mechanics”. The booklet is a workbook on bank reserves and deposit expansion (changes in a bank’s deposits-loans resulting from open market operations). The stated purpose of the booklet is to “describe the basic process of money creation in a “fractional reserve” banking system” – the monetary base plays no role at all in this analysis.
It is therefore both incorrect in theory, and thus inaccurate in practice, to refer the DAMB figure as a monetary base [sic]. The only base for an expansion of total bank credit and the money supply is the volume of legal reserves supplied to the member banks by the Fed, in excess of the volume necessary to (1) offset currency outflows from the banking system & (2) offset fluctuations in the level of member bank’s reserve balances (diverted & detained via the remuneration rate), in the 12 District Reserve Banks. The adjusted member bank legal reserve figure is that base.
7. October 2020 at 08:20
Question for Scott and Readers
I was surprised that Powell made what, superficially at least, appeared like an extreme, unclear, and unusual statement—he is warning of “tragic” danger if the Government does not have a large enough economic relief bill if combined with a long period of unneccesarily slow progress–(what is “slow progress”?–less spending?)
While he may have viewed it as irresponsible or politically incorrect, wouldn’t the better and more clear advice be something like–“we should go full Sweden”?
What is he really saying—and do you agree?
7. October 2020 at 16:13
Arilando, Don’t confuse fixed relationships and money neutrality. I am talking about a permanent exogenous change in the monetary base.
dtoh, As long as they aren’t perfect substitutes, money should still be neutral in the long run. Double M and you double all nominal variables in the long run.
Michael, Does he mean tragic for the unemployed who don’t get a check, or tragic in the sense that it impacts NGDP in a big way? The first claim seems much more plausible.
7. October 2020 at 17:19
Why is there so much confusion on this point? I suspect it has something to do with the various QE programs implemented during the recovery from the Great Recession. Large increases in the monetary base were accompanied by rather small increases in the price level and NGDP.
I don’t think that’s why. I think it’s a harder question than you’re implying. The issue comes down to “permanent.” What does permanent entail? No, I am not talking about imperfect credibility here, though of course that is a thing in the world. I am talking about whether the interaction between market expectations and the Fed’s (“permanent”) reaction function importantly incorporates conditions where the monetary base would matter.
I do not think it obviously needs to. That is, I can imagine a world in which one of Woodford’s cashless models plays out. Where, though some fancy equilibrium selection nirvana that nobody quite understands (but still happily model just like Ireland 2014 above), the Fed is able to solely use IOR to, both in fact and in off-equilibrium threat, achieve its targets. Years from now the Fed has gradually tightened, raising IOR to match rising required returns on T-bills and the base never contracts. The Fed even passes a law saying it will never again make the monetary base scarce — the convenience yield will always be zero and IOR will equal FFR = T-bills. In this case we can probably agree that swapping the base for T-bills, even permanently, is irrelevant, since the marginal base will never be anything but T-bills.
How could those models work with the Fed abandoning its monopoly on money? This is the hard question. Maybe sunspots. Or maybe Schelling focal points. Or maybe FTPL. IOR after all does give the Fed the power to switch to a neofisherian regime if it really wanted to, and claim it was raising IOR specifically to inflate (a stock split), and a big enough monetary base increase even without a convenience yield would increase the required return on Treasuries and thus increase the price level. You can all this “base money relevance” if you want, but it doesn’t apply to making current base for treasury swaps permanent. I don’t think we really know what the off-equilibrium threats are that help enforce weird regimes like IOR floor systems with satiated base money. I do think we’d be better off with a more conventional regime where the old lever of manipulating base money scarcity would obviously be a factor in the future, but I am not sure we live in that world. And I am not sure that making base money swaps for T-bills or Treasuries “permanent” matters because the market imagines some future day when base money will be scarce so it’s demand curve will slop down and its quantity will matter. I think it might matter because the market just takes it as a signal as “the fed wants to be loose” and that feeds into the black box of equilibria selection between the fed and the market.
8. October 2020 at 05:24
Scott,
No. If the the money is not exchanged for assets with the non-banking sector, it’s not neutral, it’s not even real money. It’s just an accounting entry within the banking system. It’s not any different than if JP Morgan were to put Treasury securities in a safety deposit box at the Fed and have the Fed issue them a receipt.
8. October 2020 at 05:45
re: “As long as they aren’t perfect substitutes, money should still be neutral in the long run.”
Then so is velocity.
8. October 2020 at 08:46
dlr, Of course OMOs always matter, even at the zero bound. If they didn’t then Japan would own the entire world.
Woodford’s models are not really cashless in the sense of moneyless, if I recall correctly; they have a reserve asset in which all prices are denominated. But yes, you can use IOR to control prices in some regimes without paper money. Our actual regime has lots of actual paper cash, and that’s what I’m considering here.
It’s not hard to make policy credible, all it takes is level targeting and a “whatever it takes” approach to OMOs. For instance, the Fed can peg the TIPS spread.
dtoh, It doesn’t matter how the Fed injects the money, as long as it eventually spreads through the economy.
9. October 2020 at 04:29
Scott, imho this shows the difference between American monetarists and other monetarists. British monetarists like Tim Congdon have always rejected the “money multiplier”, ratex and the idea of the monetary base being the relevant aggregate.
“From a monetarist perspective, the open market operation that leads to a contraction in the dollar volume of reserves supplied is still necessary for bringing about a permanent reduction in the price level.”
This is only from the perspective of one who puts a premium on the value of “narrow money”, even though the only institutions that hold the assets included in the monetary base in large amounts are commercial banks and the central bank. Most of the money people and businesses use in their expenditures (which are what determine prices) is demand deposits, savings deposits, and other short-term debt instruments (which are privately issued and not directly under the control of the central bank.
And yes, the British monetarists also reject a simple, mechanical relation between “expectations” of the future money growth and money growth now. Americans used to understand this, too – it’s why Fisher, Simons, Knight, etc. advocated abolishing the fractional-reserve lending system so the Treasury could directly control the stock of money.
9. October 2020 at 06:12
re: “It’s not hard to make policy credible, all it takes is level targeting and a “whatever it takes” approach to OMOs.”
The 2008 pivot already shows it can’t work. As Dr. Philip George says; ““When interest rates go up, flows into savings and time deposits increase” ( the ratio of M1 to the sum of 12 months savings ). But banks don’t loan out saved deposits. So money velocity falls.
Economists have learned their catechisms. Their upside-down think is why we are in an increasingly downward economic spiral.
The proper and only solution is to drive the banks out of the savings business.
9. October 2020 at 06:16
@ Paul re: “have always rejected the ‘money multiplier’, ratex and the idea of the monetary base being the relevant aggregate.”
What does that say about their intelligence when there is a perfect correlation between the numbers 100 percent of the time?
9. October 2020 at 07:51
From the standpoint of the system, banks don’t loan out deposits (a universally unrecognized leakage in Keynesian National Income Accounting).
If bank-held savings are not activated, put back to work into selectively targeted real-investment outlets (government incentivized and backstopped), completing the circuit income and transactions velocity of funds, then a dampening, depressing, and contractive economic impact is exerted. Dr. Philip George’s equation is apropos.
I.e., the upper income quintiles savings must be reintroduced into the economic system to avoid increasing income inequality, to avert civil unrest.
The FED, acting to offset this downswing, injects superfluous new money (generating lowering yields). Aimless new money products are introduced during the deceleration, a drop in N-gDp.
With little economic momentum, the addition to the supply of loan funds then exerts an excess of savings over potential real-investment outlets (CAPEX additions). These new funds are predominately used to finance existing products, generating asset inflation (and negative real yields).
It’s an iterative process of drag and decay.
9. October 2020 at 10:11
@Spencer B Hall
Which numbers have a perfect correlation?
9. October 2020 at 11:13
@Arilando re: “perfect correlation”
Required reserves to R-gDp and inflation. But you can’t do a regression test against the old data as the FED covers its “elephant tracks”.
I denigrated Nassim Nicholas Taleb’s “Black Swan” theory (unforeseeaable event), 6 months in advance and within one day. I predicted both the flash crash in stocks on May 6, 2010 and the flash crash in bonds on October 15, 2015.
That’s not the only thing that works.
9. October 2020 at 11:23
There were 6 seasonal, endogenous, economic inflection points each year.
(they may vary a little from year to year):
Pivot ↓ #1 3rd week in Jan.
Pivot ↑ #2 mid Mar.
Pivot ↓ #3 May 5,
Pivot ↑ #4 mid Jun.
Pivot ↓ #5 July 21,
Pivot ↑ #6 2-3 week in Oct.
These seasonal factors are pre-determined by the FRB-NY’s “trading desk” operations, executing the FOMC’s monetary policy directives: in the present case just reserve “smoothing” and “draining” operations, the oscillating inflows and outflows, the making and or receiving of correspondent and other interbank payments by and large using their “net free” (as opposed to “net borrowed”) excess reserve balances).
Each, and every year, the seasonal factor’s map (economic time series’ cyclical trend), or scientific proof, is demonstrated by the product of money flows, our means-of-payment money times its transaction’s velocity of circulation (the scientific method).
Monetary flows (volume X’s transactions’ velocity) measures money flow’s impact on production, prices, and the economy (as flows are driven by payments: “bank debits”). It is an economic indicator (not necessarily an equity barometer). Double-derivative rates-of-change Δ, in M*Vt = Roc’s Δ in AD, aggregate monetary purchasing power.
Thus M*Vt serves as a “guide-post” for N-gDp trajectories. N-gDp is determined by the volume of goods and services coming on the market relative to the actual, transactions’ flow of money.
Roc’s in R-gDp serves as a close proxy to Roc’s in total physical transactions, T, that finance both goods and services. Then Roc’s in P, represents the price level, or various Roc’s in a group of prices and indices.
Monetary flows’ propagation is a mathematically robust sequence of numbers (sigma Σ), neither neutral nor opaque, which pre-determine macro-economic momentum (the → “arrow of time” or “directionally sensitive time-frequency de-compositions”).
For short-term money flows, the proxy for real-output, R-gDp, it’s the rate of accumulation, a posteriori, that adds incrementally and immediately to its running total.
Its economic impact is defined by its rate-of-change, Δ “change in”. The Roc is the pace at which a variable changes, Δ, over that specific lag’s established periodicity.
And Alfred Marshall’s cash-balances approach (viz., a schedule of the
amounts of money that will be offered at given levels of “P”), viz., where at times “K” is the reciprocal of Vt, or “K” has the dimension of a “storage period” and “bridges the gaps of transition periods” in
Yale Professor Irving Fisher’s model.
“According to Dr. Milton Friedman, the main reason for the non-neutrality of money in the short-run is the variability in the time lag between money and the economy.”
Money and money flows are robust, not neutral, i.e., up to a point. That saturation point is determined by the rate of inflation, the monetary fulcrum. This is perfectly clear. It is aptly demonstrated by the distributed lag effect of money flows being mathematical constants, for > 100 years.
9. October 2020 at 11:52
In other words, every single recession since WWII was entirely the FED’s fault.
9. October 2020 at 13:10
Scott,
You said, “It doesn’t matter how the Fed injects the money, as long as it eventually spreads through the economy.”
Precisely. If there is no expectation that ER will be exchanged for assets with the non-banking sector, then the money does NOT matter.
9. October 2020 at 13:32
“Required reserves to R-gDp and inflation. But you can’t do a regression test against the old data as the FED covers its ‘elephant tracks’.”
Is that so? Perhaps you could explain why GDP didn’t fall to zero in March 2020 when the Federal Reserve Board eliminated reserve requirements?
9. October 2020 at 15:29
@Paul re: “Is that so?”
It’s an incontrovertible fact.
re: “fall to zero”
Funny. How does that follow? The facts speak for themselves:
We knew in advance, the precise “Minsky Moment” of the GFC:
POSTED: Dec 13 2007 06:55 PM |
The Commerce Department said retail sales in Oct 2007 increased by 1.2% over Oct 2006, & up a huge 6.3% from Nov 2006.
10/1/2007,,,,,,,-0.47 * temporary bottom
11/1/2007,,,,,,, 0.14
12/1/2007,,,,,,, 0.44
01/1/2008,,,,,,, 0.59
02/1/2008,,,,,,, 0.45
03/1/2008,,,,,,, 0.06
04/1/2008,,,,,,, 0.04
05/1/2008,,,,,,, 0.09
06/1/2008,,,,,,, 0.20
07/1/2008,,,,,,, 0.32
08/1/2008,,,,,,, 0.15
09/1/2008,,,,,,, 0.00
10/1/2008,,,,,, -0.20 * possible recession
11/1/2008,,,,,, -0.10 * possible recession
12/1/2008,,,,,,, 0.10 * possible recession
RoC trajectory as predicted. Nothing has changed in > 100 + years
The only tool, credit control device, at the disposal of the monetary authority in a free capitalistic system through which the volume of money can be properly controlled is legal reserves. The FED will obviously, some time in the future, lose control of the money stock (just like they lost control of asset inflation during the boom in real-estate.
9. October 2020 at 15:35
This is how Bankrupt U Bernanke caused the Great-Recession:
2006 jan ,,,,,,, 45496 ,,,,,,, 0.04
,,,,, feb ,,,,,,, 43084 ,,,,,,, 0.01
,,,,, mar ,,,,,,, 41242 ,,,,,,, -0.02
,,,,, apr ,,,,,,, 42920 ,,,,,,, -0.03
,,,,, may ,,,,,,, 43648 ,,,,,,, -0.02
,,,,, jun ,,,,,,, 43278 ,,,,,,, -0.01
,,,,, jul ,,,,,,, 43328 ,,,,,,, -0.03
,,,,, aug ,,,,,,, 41162 ,,,,,,, -0.06
,,,,, sep ,,,,,,, 40865 ,,,,,,, -0.08
,,,,, oct ,,,,,,, 40088 ,,,,,,, -0.08
,,,,, nov ,,,,,,, 40543 ,,,,,,, -0.06
,,,,, dec ,,,,,,, 41461 ,,,,,,, -0.07
2007 jan ,,,,,,, 43113 ,,,,,,, -0.11
,,,,, feb ,,,,,,, 41214 ,,,,,,, -0.09
,,,,, mar ,,,,,,, 39159 ,,,,,,, -0.11
,,,,, apr ,,,,,,, 41072 ,,,,,,, -0.09
,,,,, may ,,,,,,, 42699 ,,,,,,, -0.05
,,,,, jun ,,,,,,, 42034 ,,,,,,, -0.05
,,,,, jul ,,,,,,, 41164 ,,,,,,, -0.08
,,,,, aug ,,,,,,, 39906 ,,,,,,, -0.07
,,,,, sep ,,,,,,, 40460 ,,,,,,, -0.07
,,,,, oct ,,,,,,, 40161 ,,,,,,, -0.04
,,,,, nov ,,,,,,, 40331 ,,,,,,, -0.04
,,,,, dec ,,,,,,, 41048 ,,,,,,, -0.04
2008 jan ,,,,,,, 42398 ,,,,,,, -0.07
,,,,, feb ,,,,,,, 41070 ,,,,,,, -0.05
,,,,, mar ,,,,,,, 39731 ,,,,,,, -0.04
,,,,, apr ,,,,,,, 41642 ,,,,,,, -0.03
,,,,, may ,,,,,,, 43062 ,,,,,,, -0.01
,,,,, jun ,,,,,,, 41616 ,,,,,,, -0.04
,,,,, jul ,,,,,,, 42083 ,,,,,,, -0.03
The rate-of-change in monetary flows (proxy for inflation), was contractive for 29 contiguous months. I.e., Bankrupt U Bernanke deliberately forced down housing prices and turned the housing market and thus mortgages “upside down”. This turned “safe-assets” into impaired assets.
10. October 2020 at 05:16
“Monetary Policy: Why Money Matters and Interest Rates Don’t”
http://bit.ly/1OJ9jhU
Thornton: “the interest rate is the price of credit, not the price of money (i.e., the price level.)”
The FEDERAL RESERVE’s economists are vacuous.
At the height of the Doc.com stock market bubble, Federal Reserve Chairman Alan Greenspan initiated a “tight” monetary policy (for 31 out of 34 months).
Note: A “tight” money policy is defined as one where the rate-of-change in monetary flows (our means-of-payment money times its transactions rate of turnover) is no greater than 2% above the rate-of-change in the real output of goods and services.
Greenspan then wildly reversed his “tight” money policy (at that point Greenspan was well behind the employment curve), and reverted to a very “easy” monetary policy — for 20 consecutive months (i.e., despite 14 raises in the FFR (June 30, 2004 until January 31, 2006), – every single rate hike was “behind the inflationary curve”, behind RoC’s in long-term money flows). I.e., Greenspan NEVER tightened monetary policy.
And as soon as Bernanke was appointed to the Chairman of the Federal Reserve, he immediately initiated, his first “contractionary” money policy for 29 contiguous months (coinciding both with the end of the housing bubble, and the peak in the Case-Shiller’s National Housing Index in the 2nd qtr. of 2006 @ 189.93), or at first, sufficient to inflation out of the economy, but persisting until the economy plunged into an economic wring depression).
For > a 2 year period, RoC’s in M*Vt, proxy for inflation (for speculative assets), were NEGATIVE (less than zero!).*
Unfortunately, when long-term money flows peaked in July, which was reported with a lag on Aug 14, 2008 · when the government announced that the annual inflation rate surged to 5.6% in July – the highest point in 17 years; after July, both the RoC in short-term money flows and long-term monetary flows, simultaneously, fell off a high cliff (because of the lag effect of money flows).
Money market and bank liquidity continued to evaporate despite the FOMC’s 7 reductions in the target FFR (which began on 9/18/07 until 4/30/08). Bernanke didn’t initiate an “easy” money policy, continuing to drain liquidity, despite Bear Sterns two hedge funds that collapsed on July 16, 2007, and immediately thereafter filed for bankruptcy protection on July 31, 2007 — as they had lost nearly all of their value.
Bernanke’s 29 contiguous months of a massive contraction of American Yale Professor Irving Fisher’s price level, the massive tightening of monetary conditions in the US. caused a sharp rise in E-$ money, in E-$ demand. Foreign central banks did not have direct access to dollar liquidity swaps from the Fed (as illustrated by the sharp drop in EUR/USD from close to 1.60 in July 2008 to 1.25 in early November 2008).
BuB didn’t even begin to try and ease monetary policy until Lehman Brothers later filed for bankruptcy protection (it was one the Federal Reserve Bank of New York’s primary dealers in the Treasury Market, disrupting the primary dealer system), on September 15, 2008. The next day AIG’s stock dropped 60%.
I.e., BuB maintained his “tight” money policy [i.e., credit easing, or mix of assets, not quantitative easing –injecting new money and excess reserves]. BuB literally didn’t ease monetary policy until March 2009 (when the rate-of-change in money flows finally reversed, when stocks turned).
The FOMC’s “tight” money policy was due to flawed Keynesian dogma (using interest rate manipulation as a monetary transmission mechanism), rather than by using open market operations of the buying type so as to expand legal reserves and the money stock — and thus counteract the surgically sharp fall in AD, esp. during the 4th qtr. of 2008.
On January 10, 2008 Federal Reserve Chairman Ben Bernanke pontificated: “The Federal Reserve is not forecasting a recession”.
Bernanke subsequently initiated the economy’s coup de grâce during July 2008 (his second ultra-contractionary money policy). The 3rd contractionary policy was the introduction of the payment of interest on excess reserves, which destroyed non-bank lending/investing (the 1966 S&L credit crunch, where the term was first introduced, is the economic antecedent and paradigm).
Note aside: the 2 year rate-of-change, RoC in M*Vt (which the FED can control – i.e., the RoC in N-gDp), peaked in the 2nd qtr. of 2006 @ 12%. Bernanke let it fall to 8% by the 4th qtr. of 2007 (or by 33%). N-gDp fell to 6% in the 3rd qtr. of 2008 (another 25%). N-gDp then plummeted to a -2% in the 2nd qtr. of 2009 (another – 133%). That’s what created the cry, epitomized by Scott Sumner, for targeting N-gDp.
By withdrawing liquidity from the financial markets (draining legal reserves and the money stock), risk aversion was amplified, haircuts were increased, additional and/or a higher quality of collateral was required, liquidity mis-matches were magnified, funding sources dried up, long-term illiquid assets went on fire-sale, non-bank deposit runs developed (the ECB, which routinely conducts open-market operations “with more than 500 counterparties throughout the Euro Zone), withdrawal restrictions were imposed, forced liquidations lowered asset values, counterparties’ credit default risks mushroomed– all of which contributed a general crisis of confidence & frozen financial markets (regulatory malfeasance was a subordinate factor).
I.e., BuB turned Yale Professor Irving Fisher’s “price level”, or otherwise safe-assets, into impaired and unsaleable assets (i.e., upside down and under water).
I.e., Alan Greenspan didn’t start “easing” on January 3, 2000, when the FFR was first lowered by 1/2, to 6%. Greenspan didn’t change from a “tight” monetary policy, to an “easier” monetary policy, until after 11 reductions in the FFR, ending just before the reduction on November 6, 2002 @ 1 & 1/4% (approximately coinciding with the bottom in equity prices).
I.e., Greenspan was responsible for both high un-employment (June 2003, @ 6.3%), & high inflation (rampant real-estate and commodity speculation).
And BuB NEVER eased. BuB then relentlessly drove the economy into the ground, creating a protracted un-employment, & under-employment rate, nightmare.
10. October 2020 at 12:37
dtoh, You create that “expectation” by making the change permanent, which is exactly what I said in the post.
10. October 2020 at 13:41
Scott,
No. Absolutely wrong. If you make ER permanent there will be ZERO expectation that the money will ever be exchanged for assets with the non-banking sector. So the money will NOT matter. That’s essentially the situation we are in now, and precisely why the massive amount of OMPs failed to restore demand during the Bernanke recession.
11. October 2020 at 02:23
@ Spencer B Hall
Is this the data you’re talking about?
https://fred.stlouisfed.org/series/REQRESNS
Doesn’t look true at a glance.
11. October 2020 at 05:35
Arliando,
It’s not. The FRB eliminated reserve requirements in March, which, in Spencer’s model, would have caused GDP to fall to zero. In fact, it accelerated growth in the money stock due to the government backstopping of bank balance sheets to an even greater extent than normal.
11. October 2020 at 09:10
dtoh, No that’s not the situation we are in now, because there’s been no permanent injection of reserves. I’d encourage you to take a close look at Ireland’s paper, I think you are missing the point. As long as reserves and other assets are not perfect substitutes, then money is neutral in the long run.
OMOs will work fine in a level targeting regime with a “whatever it takes” approach to reserve injection.
11. October 2020 at 10:14
re: “would have caused GDP to fall to zero”
That’s not how my model works. It’s a stupid comment. Where’s the modeling, where’s my lag?
re: “glance”
You omit rates-of-change.
Example:
Thus, my prediction for the bottom in oil was:
“Lags are constants but “K” is not. K is the reciprocal of Vt. The bottom isn’t Dec. but Jan. (like last year)”
Sep 24, 2015. 11:56 AM
11. October 2020 at 10:21
re: “it accelerated growth in the money stock due to the government backstopping of bank balance sheets to an even greater extent than normal.”
How so? By mid-1995 (a deliberate and misguided policy change by Alan Greenspan in order to jump start the economy after the July 1990 –Mar 1991 recession), legal, fractional, reserves (not prudential), ceased to be binding – as increasing levels of vault cash/larger ATM networks, retail deposit sweep programs (c. 1994), fewer applicable deposit classifications (including allocating “low-reserve tranche” & “reservable liabilities exemption amounts” c. 1982) & lower reserve ratios (requirements dropping by 40 percent c. 1990-91), & reserve simplification procedures (c. 2012), combined to remove reserve, & reserve ratio, restrictions.
11. October 2020 at 10:29
And on; Dec 15, 2019 at 9:28am
Equities top 1/29/20. Short selling opportunity.
And on; Nov 26, 2019 at 6:45pm Quote by flow5 on Nov 26, 2019 at 6:45pm
The 1st qtr. R-gDp in 2020 will be negative.
Aug 14, 2020. 01:48 PMLink
11. October 2020 at 10:32
On the day the stock market bottomed, I repeated myself 3 times:
That’s B.S.
Bottom’s in.
Mar 23, 2020. 10:34 AM
Link
Margin Call: The Story Of A Historic Week – The Heisenberg
Bottom for stocks, not the economy. It will decouple.
Mar 23, 2020. 10:33 AM
Link
We Likely Saw The Bottom – Michael A. Gayed, CFA
The bottom’s in.
Mar 23, 2020. 10:28 AM
Link
Sentiment Speaks: Many Did Not Believe We Would See 2200SPX Again, And Many Will Not Believe What I Am Thinking Now – Avi Gilburt
My take, with the FED’s recent moves, the bottom is now in.
Mar 23, 2020. 10:26 AM